The battle between fiscal and monetary policy hawks continues. Elected officials around the world don’t want to balance budgets and see giving largess via special interest needs, as good political policy to stay in power. Deficit spending is out of control and it has moved to the monetary policy side to cool inflation (that the Central Banks created with low interest rates and significant liquidity). Now Central Banks have raised interest rates in most OECD countries to over 20 year highs and are doing Quantitative Tightening (QT). The push and pull of this is creating stresses that may in election years find themselves in unpalatable situations to keep their economies from heading into more than a soft landing scenario (the current thesis). 

Some of the items moving around the bulls and the economic bears are:

• The US got its credit rating downgraded on August 1st by Fitch to AA+ from AAA. In their reason for doing so they stated what it called an ‘erosion of governance’. Fitch projects US deficits will rise from 3.7% of GDP in 2022 to 6.3% this year (a whopper of an increase) and then to 6.6% in 2024 and to 6.9% in 2025. These highlight the  unsustainable spending on the fiscal policy side. Fitch sees a US recession starting in Q4/23 and lasting through 2024 but does not indicate the severity of their expectation. 
• Negative M1 and M2 money supply measures in many countries.
• Lending has tightened in many OECD countries especially in the US due to bank runs continuing and lending standards have tightened due to potential tighter Fed requirements commencing October 1st.
• Last week the FDIC took over a weak Kansas bank, Heartland Tri-State Bank and merged it into a competitor Dream First Bank. The FDIC expects to lose 40% of the failed banks assets in the forced deal.  
• The US government is planning a record US$1T of net marketable securities in Q3/23, 37% above the market expectation. Rates across the spectrum have lifted. US 2-year Treasury yields are now 4.97% up from 4.59% in mid-July but still below the high of 4.99% seen in early July. A rise over 5.0% would spook the markets. Recent bond issues have seen low bid-to-cover ratios and banks have not been big participants of longer dated paper as they work to meet tougher balance sheet requirements. 
• US Core PCE remains too high at 4.1%. This is the Fed’s favourite inflation number and they want this down to 2%. 
• US Real GDP rose 2.4% aiding the soft landing view. 
• China announced that its manufacturing data fell to 48.7 (below 50 is a contraction) and was the lowest level since June 2020.
• Manufacturing in Germany, France and Italy are showing marked declines since June.

The war in Ukraine is seeing more escalations as one side hits the other and this is now spreading to daily drone attacks on Moscow by Ukraine and the Black Sea Ukrainian grain ports being blockaded and attacked by Russia. A lot of the grain infrastructure at the export Ukrainian ports has been severely damaged. 

Some recent events: 

• The major offensive by Ukraine has started according to President Zelensky now that the NATO trained and equipped brigades are in the front lines. Total forces by Ukraine are believed to be over 150,000.  So far no bragging rights for Ukraine as stubborn defending by Russian forces behind trench lines and massive mine fields slows down the Ukrainian forces. An incredible number of drones (tens of thousands daily) for intelligence and attacking are being seen across the battlefield. Russia seems to have learned from their earlier battlefield mistakes and with multiple lines of defense seem to be keeping the  Ukraine offensive from succeeding. 
• Biden has ordered more military reserves to backstop NATO forces and to maintain equipment given to Ukraine. 
• Ukraine’s accuracy with its drones is getting better. They hit buildings in the heart of the Oligarch’s compounds, and the Moscow airport. This is bringing the war to everyday Russian citizens. 
• The Wagner group has moved to Belarus and is rebuilding. They are also training Belarusian troops to join them when they next go on the offensive. Some forecasters see them going after Ukraine from the north (maybe towards Kiev), others that they may attack NATO supply depots in Poland, Romania or the Baltic States. Euro news speculates that the Wagner troops could ‘cut-off’ the Baltic States from NATO.
• Bottom Line:  This war is dragging out and the Russians would love to see miniscule success by the Ukrainian counter-offensive once fall is over and winter arrives, moving the next fighting season to spring 2024.

Market Movement:  Overall earnings expectations for the S&P 500 are a decline of >7% in earnings comparisons from last year. Stock multiples are high and if earnings are heading downward there can be a material near term correction. We are watching the 33,600 level for the Dow, which if breached would complete a topping formation for the Dow. A close below 32,600 would set up the waterfall decline phase to below 30,000. Stay patient with cash reserves and be ready to BUY at the next low risk entry point. Don’t get trapped by this current euphoria. 

The start of energy earnings results shows weaker comparisons. Last year in Q2/22 WTI prices averaged US$108.57/b and this year US$73.99/b or down by 32%. So comparison this quarter may prove disappointing especially for natural gas focused entities. Last year AECO traded at C$6.27/mcf and this year at C$2.35/mcf, or down by 63%. The early E&P reporters are showing weaker cash flows and free cash flows. 

Get ready to be buyers once this expected correction has lowered stock prices and fear has returned to the markets. The CNN Fear & Greed Index was recently at an extreme greed reading of 84, pushing near a record high. Recent market weakness has pulled it down to 68 today. Bottoms usually occur below a 20 reading. The S&P Energy Bullish Percent Index rose last week to 91% (a take profits level). It is now backing off and we expect to see when the general stock market plunges into near exhaustion that it will again give a BUY signal below 10%. 

We are waiting for the stock market to get oversold again to add to our energy investments. Many energy stocks are down over 50% from their 2022 highs, and many trade again below Proved Developed Producing (PDP) Reserve valuations levels. If you want to see what our subscribers are looking at, sign up now for access to the Schachter Energy Research reports. We expect to add additional ideas during this next decline phase especially if the S&P Energy Bullish Percent Index falls below 10% and triggers the next BUY signal.